Three must-haves in the consumer discretionary jungle

Financial journalist
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One of the big domestic investment themes posited for 2014, is the handing of the economic-growth baton from the resources sector to the non-resources sector. But judging by the stock market, that process well and truly got under way last year.

The star of the show

In particular, the consumer discretionary stocks sector was star of the stock market in 2013, up 36.3%, powered by the sub-sector of specialty retail.

Gradually, the prevailing record-low interest rates and housing market recovery are supporting a recovery in consumer confidence, and retail sales are strengthening. On the most recent Australian Bureau of Statistics (ABS) figures, Australian retail spending rose by 0.7% in November, beating economists’ expectations of a 0.4% rise.

That was the seventh consecutive monthly rise for retail sales, and took the figure to a level 4.6% higher than a year ago, with the all-important Christmas numbers to come. Given that as recently as June 2013, annual retail sales growth was running at a near-record low of 1%, consumers have clearly begun to unlock their wallets.

But this is not a uniform trend. In November, department-store sales actually fell over 12 months, down 1.2%. In contrast, clothing specialists lifted sales by 10.5%, while restaurant turnover was up 8.3% on a year ago. Spending on household goods rose 4%. Deutsche Bank reckons retail stores have continued to do well over Christmas and into the New Year; Commonwealth Bank economist Gareth Aird says “increased wealth is being transferred to a lift in consumer spending.”

The big guns

The stellar performance of the consumer discretionary stocks as a group was driven by some extremely strong gains, but there were some big losses as well, as is obvious in the following table.

Source: Stock Doctor – 13 January, 2014

Better for some than others

Clearly, the last few years have been more of a struggle for some retailers than others. The rejuvenated Australian consumer and the lower A$ should help the sector: in particular, the weaker $A should bring some respite to those retailers who compete against products bought online from overseas, which is a less-attractive transaction than it would have been a year ago, with the dollar near or above parity with the US dollar.

However, a lower Aussie dollar is not a panacea for the likes of Harvey Norman, JB Hi-Fi, David Jones, Myer and Premier Investments, because it both increases the landed costs of the goods they bring in from overseas, and makes it easier for the Zaras, Top Shops, H&Ms, Forever 21s and Uniqlos of the world to expand into the Australian market.

Many of the retailers are pinning their hopes on the online playing field being evened somewhat by having the Australian goods and services tax (GST) applied to overseas purchases worth less than $1,000, but even there, the fact is that the large international retailers, especially those from the US, can simply offer much lower prices because they have lower labour costs and better buying prices. Even the costs of shipping to Australia are largely offset by the lower costs of the big online retail sites.

The must-haves

So while consumer discretionary is a tough business, the share price performance of many (not all) of the participants has belied this to a significant extent. And the strong returns posted by the sector index and the even better returns generated by many of the constituents raise the obvious question – is there any value still to be found?

The answer appears to be yes – even in some of the stronger performers.

1. Oroton (ORL)

Source: Yahoo

Oroton is considered to have 15% upside to the target price, and a 5.3% fully franked yield. Clearly, many investors were tempted to mark Oroton down last year on the back of two seemingly-big negatives: the resignation of the highly regarded Sally Macdonald as chief executive officer and the severing of the company’s 23-year relationship with Ralph Lauren, which expired in June 2013. The exclusive Ralph Lauren licensing agreement represented 45% of Oroton’s sales and 35% of net profit: not surprisingly, Oroton has forecast a 30% drop in earnings for 2013-14.

But if you look closer, the company – under new CEO Mark Newman, who worked closely with Macdonald – has freed-up capital to expand its own brand into Asia, and can grab opportunities from which it was barred while working with Ralph Lauren.
The perfect example is the 10-year joint venture agreement announced in August 2013 with US fashion brand Brooks Brothers that will see Oroton – which has 51% of the joint venture – open four to eight Brooks Brothers stores and department store concessions this financial year, the first Brooks Brothers’ outlets in Australia. Oroton expects revenue from the joint venture to reach $50 million in five years. This is while Oroton opens its own stores in China and the Middle East

The Brooks Brothers deal was followed in October by an exclusive 10-year franchise agreement with Gap Inc. to develop the Gap brand in Australia and New Zealand, with first rights to develop the Banana Republic brand in these countries, and the potential opportunity to develop the Old Navy brand as well. Who needs Ralph Lauren?

2. Nick Scali Furniture (NCK)

Source: Yahoo

Nick Scali Furniture looks even better, with about 19% of potential upside and a 4.8% fully franked yield (FY14) – the caveat there is that NCK is a lightly-traded stock. With a housing recovery well under way, Nick Scali is well positioned for its plans to move into the Perth market this financial year, with New Zealand the next target. The company says its strategy is to increase its store numbers from the current 38 to 80, in both the main brand and the lower-priced Sofas2Go brand, although it has not given a time frame. That should flow through to improved profitability, although the company’s main challenge is to maintain its margins, as a weakening A$ makes its stock more expensive to import.

3. Specialty Fashion Group (SFH)

Source: Yahoo

Specialty Fashion Group, at 89 cents, has 16.9% potential upside to the consensus target price of $1.04.

In November 2013, for a seemingly bargain-basement price of $5 million, Specialty Fashion picked up the Rivers chain, with its 160 stores and $180 million turnover. SFH says Rivers could expand to 220 stores, by leveraging off the group’s database of seven million customers and maximising economies of scale.

If it gets the Rivers integration right, Specialty Fashion will have paid a pittance for an asset that moves it out of its specialty women’s fashion market, and into the footwear and men’s and children’s clothing markets, in the ‘value’ segments. The company says the material benefits from the Rivers acquisition will flow through from FY2015.

Specialty has reacted to the big challenges facing apparel retailers by investing in its design team, to differentiate the range from the foreign invaders, and has also boosted its online retail presence, which now accounts for about 4% of revenue.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

 

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